What is meant by materiality in accounting?

May 16, 2015

Should a reasonable investor be influenced by a 5% error in net income? Or would a 10% variation make a difference to the investor? The answer is related to the concept of materiality. In this accounting article we define materiality, list a few possible approaches to calculating materiality, and provide examples of the application of the materiality concept in accounting.

1. Defining materiality

Disclaimer: This article is for information purposes only.  Please consult a professional with specific questions that may relate to your situation.

The Financial Accounting Standards Board (FASB) defines materiality as "The magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement."

In other words, if accounting information (or its omission) can influence economic decisions of accounting information users, it is considered to be material.

For instance, if a company had overstated its revenues by $5 million, when its total revenues are $15 billion, it is likely that the $5 million misstatement would not make a significant difference to investors (e.g., creditors, management). However, the same $5 million overstatement is likely to be considered material when the company's total revenues equal $40 million.

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